Restriction of pensions tax relief: Sackers’ response

Background

From April 2011, the Government’s intention is that tax relief on pension savings should be reformed – to reduce the complexity introduced by the former Labour Government’s plans for restricting pensions tax relief, while raising at least the same amount of revenue.

On the basis of provisional analysis, the main proposal in the consultation document published on 27 July 2010 by HMT and HMRC is a reduction in the AA to an amount in the region of £30,000-£45,000.  There are a number of policy design features which flow from this.

We set out below our comments on a number of practical issues arising from the consultation.  However, given that many of the questions posed by the consultation are actuarial in nature or aimed at some of the more practical implications for employers and trustees, we have not attempted to answer all of the questions raised in the discussion document.

In this response:

• General Comments
• Valuing defined benefit contributions
  
• Other issues around the valuation of DB contributions
• Applying the AA in particular circumstances
• Redesigning the system of pensions tax relief
• Options for managing impacts
  
• Managing high charges
  
• Alignment of the pension input period with the tax year
• Information requirements

General Comments

The original aims of pensions tax “simplification” – removing complex Inland Revenue limits and replacing them with a system of allowances for tax-efficient saving – have recently looked in danger of disappearing.  In particular, the introduction of anti-forestalling and the complicated measures designed to restrict pensions tax relief contained in the Finance Act 2010 (FA2010) have both given rise to concerns in this regard.  As such, we agree that the approach envisaged in FA2010 could have unwelcome consequences for pension saving, and therefore support the Government’s quest to simplify the measures that it will use to achieve its fiscal aims.

In terms of timing, the proposed implementation date of April 2011 is likely to leave insufficient time for employers and trustees to make coherent plans and implement any necessary changes to their scheme rules to take account of a reduced AA.  By contrast, there was nearly a two year lead-in period after the Finance Act 2004 (FA2004) received Royal Assent, before the original tax simplification measures came into force.  In addition, stakeholders were to have had a year, following the granting of Royal Assent on FA2010, before the coming into force of the previous Labour administration’s proposed tax relief restrictions.

Given that we have not yet had sight of draft legislation, let alone final regulations, to implement the present proposals, we wonder whether there is any possibility of implementation being deferred until April 2012.  This would enable full consideration to be given to the draft legislation by the industry, with the aim of ensuring smooth implementation once the provisions come into force.

Valuing defined benefit contributions

The methodology for valuing DB contributions is clearly an actuarial, not a legal, question.  However, using either a CETV calculation or age-related factors (ARFs) would represent a departure from the current methods used for valuing benefits under FA2004 for testing against the AA and the LTA.  These are currently based on the “flat factor” method described in the Consultation, namely the value of the increase in the benefit is multiplied by a factor of 10:1 and 20:1 respectively when assessing the AA and the LTA.

The Government’s proposal favours the arguments for simplicity over the need for a precise valuation methodology and, in our view, simplicity and clarity are highly desirable.  Requiring schemes to carry out CETV calculations would impose a significant additional administrative burden on schemes, while ARFs, although attempting to capture a more precise valuation methodology, would be complicated to administer and would still only cover a limited number of variables (for example, age).

The consultation notes that “the Government does not believe past service should be excluded from the calculation of pension accrual used to value DB pension rights”.  Our comment here is that revaluation is applied (in deferment) to protect the value of past service benefits.  However, as schemes apply different rates of revaluation, a requirement to take account of past service benefits for the purpose of valuing DB contributions, would add an unwarranted layer of complexity.

Other issues around the valuation of DB contributions

The consultation asks whether the previous year’s benefits should be revalued for the purposes of determining new accrual.  In our view, taking account of inflation on past service benefits would also create unnecessary complexities, as revaluation is designed to apply when a member becomes deferred.

We do, however, agree with the Government’s provisional view that any negative accruals be treated as zero under the AA approach, on the grounds of fairness and ease of administration.

Applying the AA in particular circumstances

We agree with the Government’s comment that individuals who are diagnosed with serious (terminal) ill-health are unlikely to give rise to a material avoidance risk and that it would be appropriate for an exemption to apply in these circumstances.

However, whilst we recognise that there may be a risk of avoidance in certain cases of ill-health early retirement or on redundancy, this is unlikely to be the case in larger, well run schemes which benefit from good governance practices.  In addition, an ill-health retirement has to meet the test set out in paragraph 1 of Schedule 28 to FA04 for the pension to be authorised.  We believe that this already provides protection against avoidance.

As a result of the present economic crisis, many individuals may still face the prospect of redundancy.  Redundancy exercises usually apply to a group of individuals and scheme rules often provide for an enhanced early retirement pension benefit where the member is over a certain age (typically this had been age 50).  (Such early retirement provisions are very common in the public sector, as well as in private sector schemes which have their origins in the public sector or quasi public sector bodies.)

It would, in our view, be very helpful if something could be done for individuals in these circumstances, perhaps by assessing contributions over a two-year period, or ignoring any payment made under the terms of a redundancy scheme that is open to all employees with that employer.  We suggest that such redundancy packages fall outside the scope of the restrictions on tax relief (or that a limit is placed on redundancy payments in these circumstances), especially where the individual has not previously exceeded the reduced AA threshold.  Such enhanced benefits have formed an integral part of scheme rules for many years and are not within the affected individual’s direct control. Similar considerations apply to a member who qualifies for an enhanced ill-health early retirement benefit.

In practice, employers and trustees are likely to encounter difficulties in making changes to such benefits, under scheme rules and section 67 of the Pensions Act 1995, if they seek to do so without obtaining member consents.

Redesigning the system of pensions tax relief

In relation to the proposals for adapting the LTA to ensure more coherence between this and the AA, our main concern is that any changes are simple to understand and administer.

The methods for grandfathering pre-existing rights as at A-Day, set out in schedule 36 to FA2004, are highly complicated.  Any extra layers added to this will therefore need to be drafted with care.

Options for managing impacts

Chapter 3 of the consultation looks at some of the options for employers to adjust reward arrangements and scheme design to support individuals wishing to aim off the AA and to prevent or limit spikes in pension accrual or contributions.

As for 4 above, in practice, employers and trustees will encounter a number of problems should they wish to implement these suggestions.  For example, scheme rule amendment powers may be restrictive, consideration will need to be given to the restrictions contained in section 67 of the Pensions Act 1995 and the HR implications of any such adjustments will need to be factored in.

Although statutory overrides have been used in the past to enable schemes with restrictive amendment powers to make changes, these have been used for very specific issues, such as allowing schemes to take advantage of the reduction in the statutory cap on pension increases under section 51 of the Pensions Act 1995 (as amended).  Given the many variables in terms of different scheme rules, a blanket override to deal with a reduced AA would necessarily be very wide, with the risk of ultimately cutting across existing protections for scheme members.  In this respect, we note that the consultation focuses on the employer’s perspective in managing the impact for individuals, without considering the duties of occupational pension scheme trustees.

Managing high charges

We note that the Government is keeping this issue under review and assume that there will be a separate consultation on the support options referred to in the consultation, which will be legislated for in the Finance Bill 2012.

In connection with any proposals to enable schemes to pay charges on behalf of members directly to HMRC, section 91 of the Pensions Act 1995 prevents a member’s benefits under an occupational pension scheme being assigned, commuted or surrendered, except in very limited circumstances.  If measures enabling schemes to pay some or all of a member’s charges go ahead, a further exception would need to be built into section 91 to allow schemes to deduct those tax charges.

A substantial reduction in the AA is likely to catch a greater number of pension savers than the previous administration’s proposals would have done.  Any changes introduced should therefore weigh up the potential impact of an increased administrative burden on schemes, with the benefit for individuals who may be facing substantially higher tax charges as a result of the AA changes receiving both information and assistance from their schemes.

Alignment of the pension input period with the tax year

The PIP is the period used to assess the annual increase in the value of a member’s benefits for the purpose of testing against the AA.  Under the A-Day changes, trustees of occupational pension schemes were generally able to nominate the most appropriate PIP for their scheme (for example, to coincide with the scheme year).  However, the position in DC schemes was more complicated as members could also determine their own PIP.  Where nominations were made by both the trustees and a member, the legislation gave priority to the first nomination past the post.

Although our own experience is that DC scheme trustees generally nominated a scheme-wide PIP as soon as possible after A-Day, or for new schemes as soon as possible after being established, it is nonetheless conceivable that in some DC schemes there may be any number of PIPs in operation.

Given the different PIPs currently used by schemes/individuals, it is possible that some people are currently already in a PIP which would ultimately be caught by the proposed changes if they are introduced in April 2011.  We therefore suggest that the transitional provisions include some form of smoothing for the first year.

For the above reasons, and depending on a scheme’s administration systems and the ease with which they can be changed generally, bringing the PIP into line with the tax year may cause difficulties for some.

Information requirements

Whilst employers and trustees may wish to help staff with the new pensions tax requirements, we do not think that there should be a need for schemes to provide information automatically to members for AA purposes.  Instead, we consider that it would be appropriate to apply a system of individual requests, akin to that which currently exists for CETVs.

Although it is expected that more people will be affected by a reduced AA than by the earnings limit contained in FA2010, the increased burden on individuals in connection with their tax affairs should not necessarily be simply passed onto schemes as this could represent a considerable additional burden, especially in already underfunded DB schemes.  In any event, as in most cases employers and trustees will not be aware of an individual’s concurrent pension arrangements (if any), the onus should remain on individuals to assess their own tax position.  Trustees could, however, include a statement in scheme booklets reminding members to review their pensions accrual or contributions against the AA, and perhaps issue an annual reminder.

In the run-up to the introduction of a reduced AA and associated amendments to the pensions tax relief system, the Government will need to raise awareness of the changes, so that people potentially affected them are fully informed of their tax obligations.